The Provison of Investment Advice Under Prohibited Transaction Exemption 97-60

Summary:

The Department of Labor recently issued a prohibited transaction exemption (PTE 97-60) to an ERISA investment advisory firm, the Trust Company of the West (TCW), allowing it to provide investment allocation and investment advice to participants in ERISA §404(c) individual account plans. The advice includes a recommendation to invest in group trusts set up by TCW which contain mutual funds managed by a sister company. The author of the following article was involved in obtaining the exemption and explains its potentially groundbreaking significance.

For additional information concerning prohibited transaction exemptions, see 365 T.M., -ERISA-Fiduciary Responsibility and Prohibited Transactions.

In Prohibited Transaction exemption 97-60 (PTE 97-60) the Department of labor grants exemptive relief under §408(a) of the Employee Retirement Income Security Act of 1974, as amended (ERISA) and §4975(c)(2) of the Internal Revenue Code of 1986, as amended (the Code) [1] on behalf of The TCW Group, Inc., and its wholly-owned subsidiaries Trust Company of the West (TCW), TCW Funds Management, Inc. and TCW Galileo Funds, Inc.

DESCRIPTION OF TCW PORTFOLIO SOLUTIONS PROGRAM

TCW has created a program entitled “TCW Portfolio Solutions” (the Program) under which TCW will render investment advice to plan participants [2] in “Benefit Plans,” which are individual account plans qualified under §401(a), et seq. of the Code, providing for participant self-direction. The Program is based on a very simple idea: to provide the individual plan participant responsible for the investment of his or her account balance with a convenient way to benefit from the knowledge and experience of professional investment advisers and thereby receive advice concerning which Life Cycle Trust represents an appropriate allocation of the assets in that individual’s account.

Under the Program, TCW will recommend to participants one of the Life Cycle Trusts maintained under the Program or a money market fund or similar vehicle as an investment vehicle for the participant’s account balance. Initially, there will be four such Life Cycle Trusts [3] (although more may be added in the future), which will be structured as four separate commingled trusts (each a “Trust” and collectively the “Trusts”) and a Money Market Fund or a Guaranteed Investment Contract or similar vehicle.[4] Each Trust will bold, in varying proportions, shares of some or all of the thirteen mutual funds [5] (each a “Fund”) offered by TCW Galileo Funds, Inc. (the Galileo Funds), an open-end management investment company.[6] The mix of Galileo Funds in each Trust will be designed to accommodate the different investment strategies of each of the Trusts. In this regard, the Trusts range from aggressively structured (generally comprised of Funds which invest mainly in equities) to conservatively structured (generally comprised of Funds which invest mainly in fixed income instruments). The Trusts may comprise all or some of a Benefit Plan’s investment alternative.

DOL issued Interpretive Bulletin 96-1 [7] (the”IB”) which encourages and facilitates the provision of investment education of participants and beneficiaries. The IB accomplishes this by describing information which will not constitute investment advice. Therefore, a person will not become a fiduciary by providing such information.

In contrast, TCW intends to assist participants by providing investment advice. In assuming such fiduciary responsibility, TCW intends to directly assist participants in making appropriate investment decisions. The Program will be offered to an Independent Fiduciary [8] of a Benefit Plan. In accordance with its responsibilities under Title I of ERISA, the Independent Fiduciary must review the Program before offering it under the Benefit Plan. Once the Independent Fiduciary approves the Program for its Benefit Plan TCW will provide each plan participant, in writing or otherwise [9], with Worksheets, which will, through a series of questions, elicit from participants. their retirement funding needs and level of risk tolerance. Upon completion of the Worksheets, the participant’s response will be analyzed and the participant will receive a written recommendation of an appropriate Trust.[10]

TCW’s recommendation of a particular Trust is designed to assist a participant in choosing the appropriate asset allocation based on the participant’s risk profile, retirement needs and life cycle stage. Appropriate asset allocation [11] is essential to realizing favorable market returns. Appropriate asset allocation is often a function of the participant’s stage of life. It is generally accepted that younger participants with longer time horizons should invest in a more equity-weighted Trust, whereas older participants with shorter time horizons and lesser funding needs should invest in a more bond/money market-weighted Trust. The Program initially provides four different Trusts designed to assist a participant in achieving his or her retirement funding needs, by varying the weightings of the Trusts holdings. By tailoring the Trusts to meet individuals’ different retirement needs, the Trusts employ concepts similar to those imposed under DOL’s prudence regulation, wherein plan investments must be made in view of the plan’s funding needs and prescribed risk tolerances. Thus, a recommended course, of action which incorporates the prudent practices and procedures of retirement funding applicable to defined benefit plans is provided to defined contribution plan participants.

Any solution to the problem of plan participants allocating their account balances in a less than optimal manner must take account of the typical participant’s tendency to change investments in reaction to short-term performance trends. Short-term market volatility has proven to be the nemesis of individual investors, influencing them to “buy high and sell low.” The Program minimizes this adverse effect in two ways. First, the Worksheets will elicit the information necessary for TCW to recommend the Trust appropriate for each individual participant. This will be accomplished by determining for each plan participant into which Trust he should invest, taking into account the “fear factor” (i.e. the typical participant’s inordinate fear of losing any money) and the expected fluctuation in net asset value of each Trust. Second, each Trust is a portfolio containing varying percentages of different asset classes through its investments in the Funds. This design was implemented to take into account the fact that the investment performance of different asset classes is imperfectly correlated, thus buffering short-term fluctuations in the portfolio’s overall value. Because plan participants will see only the net asset value and fluctuation at the portfolio level, i.e., of the Trust itself, they will not be unduly alarmed by fluctuations in the value of the shares of any one Fund. Furthermore, since each Trust is a portfolio of composite asset classes through its investment in the Funds, fluctuations in the value of the shares of the different Funds should mitigate portfolio fluctuations. This will help protect plan participants from succumbing to the temptation of selling a failing asset class in a- down market. In fact, quite the opposite will occur in that, to be maximally advantageous to plan participants, the asset classes in each Trust will be periodicaly re-balanced.

THE COMPONENT ELEMENTS OF TCW PORTFOLIO SOLUTIONS PROGRAM

TCW Portfolio Solutions Life Cycle Trusts

The Program will make available to participants a selection of four Trusts [12] and a Money Market Fund or Guaranteed Investment Contract or similar vehicle. The Trusts will invest exclusively in shares of some or all of the Funds in varying proportions, so that each Trust will accommodate different investment needs and risk tolerances. The Trusts are designed to provide appropriate asset allocation for four different “profiles” of participants, with the salient factors being: financial objectives, time horizon, other savings and risk tolerance.

TCW will engage a Financial Expert [13] to construct appropriate asset allocation models for the Trusts [14], using generally accepted principles of modern portfolio theory. The asset allocation models will not be static, but rather the Financial Expert, in his sole and absolute professional discretion, may make adjustments to them, taking into consideration the investment goals and risk tolerances that the allocation models represent and to account for changes in the economy and market conditions. The Financial Expert is independent from, has had no pre-existing relationship with, and is in no way under the control of, TCW and its affiliates. Moreover, no more than five percent (5%) of the Financial Expert’s gross income in any one of his taxable years will be derived from TCW or its affiliates.[15]

The Financial Expert is entirely responsible for determining how the allocation models are best implemented and, thus, will select which Funds each Trust will hold and the weightings thereof in order to be in compliance with its asset allocation model. Once the Trusts are appropriately invested in the Funds, disproportionate investment performance by the Funds will cause the Trust’s investment mix to drift from the Trust’s asset allocation model. In this connection, the Financial Expert will develop a mechanical formula to rebalance the relative value of the Funds in each Trust on a predetermined basis. Such formula and asset allocation of the Trusts will be available to each Independent Fiduciary before the Benefit Plan’s investing the Program.

Benefit Plan Sponsors

The Program will be made available to sophisticated Benefit Plans, i.e., those with a minimum of $5 million in assets. The Independent Fiduciary of a Benefit Plan must evaluate the Program and determine whether it is appropriate for a Benefit Plan. In order to assist an Independent Fiduciary in making this determination, TCW will provide: a brochure describing the Program; a contract containing the terms and conditions of the Program which the Independent Fiduciary must execute before the Program is offered to the participants; full disclosure concerning the composition of the Trusts, and, if requested, the mathematical formulae by which the asset allocation model for each Trust was derived; a reference guide/disclosure document providing detailed information concerning how the Program works; the Funds’ prospectus; the expenses charged at the Trust level; and related information.

Benefit Plan Participants

One of the primary goals of the Program is that it be as simple and user friendly as possible, while maintaining integrity and accuracy in investment advice proffered. This will be accomplished by TCW acting as a fiduciary in making a specific recommendation based solely upon information provided by or on behalf of Benefit Plan participants. To that end, TCW will provide each Benefit Plan participant with Worksheets which, through a series of questions, will elicit from the participant his or her funding needs and levels of risk tolerance. TCW will hire a respected, independent third party to formulate a risk profile (the Behavioral Expert). The Behavioral Expert will develop standards which take into account the participant’s “fear factor,” thus providing a recommendation which the participant is likely to maintain. This will be determined by asking questions designed to elicit what a participant would do if a loss, equaling the largest that could occur in the great majority of the likely scenarios, does occur. If the answers indicate that the participant would sell his or her units in such Trust in the face of such a loss, a more conservative Trust will be recommended. The results of a participant’s risk profile will only be used to recommend the same or a less aggressive Trust.[16]

This process is designed to provide participants with a better understanding of the Program by emphasizing its purposes and goals. Such understanding should better enable participants to maintain their position in the Trust which is ultimately recommended because maintaining such position is consistent with the information supplied by the participants themselves.

Whether a participant elects to invest in the recommended Trust is entirely within the participant’s discretion; in other words, the participant may disregard the recommended Trust, yet still invest in another Trust. Moreover, the Program imposes no limit on bow often a participant may change his or her investment election. Theoretically, a participant could change the investment selection any day the stock and bond markets trade; however, Benefit Plan sponsors might, as a matter of design, impose other limits.

Fees and Expenses

The total amounts received by TCW and its affiliates for services they perform for the Trusts will constitute no more than reasonable compensation.[17] In fact, the only fees, other than the reimbursement of direct expenses, that the TCW Group will receive for such services are the fees from the Galileo Funds charged to all other investors. There will be no separate fee at the Trust level for asset allocation or investment advice services.

The Independent Fiduciary of a Benefit Plan will be fully informed of the services that will be provided by or for the Trusts, for which TCW will seek reimbursement from the Trusts. These expenses include: expenses for the Financial Expert and Behavioral Expert and the development of the risk tolerance component of the Worksheets, expenses payable to regulatory authorities, accounting, auditing and legal expenses, clerical and administrative expenses, expenses of printing and mailing reports, expenses for computer programmers, certain insurance (including errors and omissions) and fidelity bond premiums and any other expenses incurred by each Trust in the ordinary course of its business.

All services for which TCW will seek reimbursement will be “necessary services”[18] provided pursuant to a reasonable contract or arrangement [19] and for reasonable compensation. [20]Although TCW anticipates that many such services will be “out-sourced” to entities independent of TCW and its affiliates, TCW or its affiliates may perform some such services. In this regard, in accordance with DOL’s regulations, no direct expense will represent any portion of TCW’s overhead costs. With respect to all such services, TCW will, and would in any event have every incentive to, procure for the Trusts service arrangements which reflect the best possible value, and thereby make the Program more attractive to clients. Moreover, the total cost of all expenses which are necessary for the operation of the Program, whether or not outsourced, will amount to no more than 1.0% per annum of the average daily net asset value of the shares of the Funds and cash or cash equivalents held by the Trusts.[21]

TCW will generally pay for direct expenses and seek reimbursement from the Trusts. This might be construed to be an extension of credit between a plan and a party-in-interest which is prohibited under sections 406(a)(1)(B), 406(a)(1)(D) and 406(b)(2) of ERISA. However, relief is likely available under PTE 80-26 concerning interest free loans between a plan and a party-in-interest.

THE PROHIBITED TRANSACTION PROVISIONS FROM WHICH EXEMPTIVE RELIEF IS GRANTED

Overview

TCW has received exemptive relief for: (1) the receipt of variable fees as a result of the provision of investment advice to Benefit Plan participants; and (2) the purchase and sale (acquisition and disposition) by Benefit Plans of units in the Trusts and shares of the Galileo Funds.

ERISA §406(a) prohibits a fiduciary with respect to an employee benefit plan from causing the plan to engage in certain prohibited transactions, including the sale or exchange of property between a plan and a party in interest, the furnishing of services between the plan and a party in interest and the transfer to, or use by or for the benefit of, a party in interest of any assets of the plan. ERISA §406(b) -prohibits a fiduciary from dealing with a plan in his own interest or for his own account; from acting on behalf of a party whose interests are adverse to a plan in any transaction involving the plan; or from receiving consideration for his own account from a party dealing with the plan in connection with a transaction involving plan assets. ERISA §408(b)(2), however, provides that “the prohibitions provided in §406 shall not apply” to the provision Of “services” “necessary for the establishment or operation of the plan, if no more than reasonable compensation is paid therefor.” However, the regulations at 29 CFR §2550.408b-2(a) state that ERISA §408(b)(2) provides an exemption only from ERISA §406(a) and “does not contain an exemption from acts described in 406(b) …”

Under 29 CFR §2550.408b-2 f, a nondiscretionary investment adviser may propose “to perform for additional fees portfolio evaluation services in addition to” investment management services. The investment adviser may “arrange” and then provide the additional services, if they are approved by an independent fiduciary, so long as that independent fiduciary is “prudent in his selection and retention of [the investment adviser] and other investment advisers of the plan. Under 29 CFR §2550.408b-2(f), Ex. 2, a nondiscretionary investment adviser (C), by recommending the purchase of an insurance contract on which C will receive a commission from the insurance company, engages in an act described in ERISA §40 6(b)(1) (as well as ERISA sections 406(b)(2) and (3)), even though C has fully disclosed the reasons for the recommendation and the fact that it will receive a commission, and an independent fiduciary considers the recommendation and approves the transaction.

Since an Independent Fiduciary of a sophisticated Benefit Plan must decide to enroll in the Program and TCW has every incentive to ensure that services are provided at the Trust level in the most cost effective manner possible because it does not profit from providing such services, TCW believed that the provision of services under the Program should not be a violation of ERISA §406(a), because such transactions would likely be exempt under ERISA §408(b)(2). However, purchases and redemptions of interests in the Trusts and Funds are not “services” and thus would not be exempted under ERISA §408(b)(2). As discussed above, ERISA §408(b)(2) does not exempt transactions under ERISA §406(b). Therefore, if TCW were deemed to be a fiduciary by virtue of the advice it renders, it could be deemed to engage in a prohibited transaction because, in general, the profits it receives will vary depending upon which Trust a plan participant selects.[22]

Accordingly, TCW sought and received an exemption: (1) from the provisions of ERISA §406(b) with respect to the provision of advice; and (2) from the provisions of ERISA §406(a) with respect to the purchases and redemptions of interests in the Trusts and Funds.

Discussion

Purchase and Sale Transaction

Since the issue concerning whether the Trusts and the Galileo Funds are parties in interest with respect to Benefit Plans has not been resolved by DOL, TCW sought and received relief from the restrictions of ERISA §406(a)(1)(A) and §406(a)(1)(D) with respect to the purchase and sale of units in the Trusts and shares in the Galileo Funds. In support of the exemption, TCW noted that its proposed exemption is similar to Prohibited Transaction Exemption 91-1 granted to Philippe Investment Management, Inc. (PIM). DOL granted such exemption, as the Program provides the following protections from overreaching and self-dealing:

1. TCW will provide the Independent Fiduciary of each Benefit Plan with a current prospectus concerning the Galileo Funds and full and detailed written disclosure of the investment management fees and all other expenses and transaction costs charged to or paid by the Benefit Plan at both the Galileo Fund and Trust level.
2. The Independent Fiduciary alone determines to select and retain the Program for the Benefit Plan. TCW will not use any authority which would make it a fiduciary to cause a Benefit Plan to elect or retain the Program.
3. A Benefit Plan will pay no more or receive no less for a unit in the Trusts or share of the Galileo Funds than the Benefit Plan would have paid or received in an arm’s-length transaction with an unrelated party. This is presumptively so as the Galileo Funds are no-load mutual funds which trade at net asset value and the Trusts trade at the net asset value of the amalgam of the Galileo Funds in which they are invested (less accrued Trust expenses).
4. The broker-dealers who effect and execute trades on behalf of the Galileo Funds are engaged on a “best execution” basis and are independent of and unaffiliated with the TCW.

Investment Advice

TCW generally receives higher net fees (and, thus, could receive higher net profits) if a participant invests in the more aggressive equity-based Trusts. Therefore, the advice rendered to the plan participants by TCW could be viewed as involving an act of prohibited self-dealing [23].

• Although there is an argument that PTE 77-4 [24] provides relief from transactions occurring under the Program, it is not absolutely clear that PTE 77-4 provides such relief for several reasons.
• First, the fourth requirement of PTE 77-4 provides that an independent or so-called “second” fiduciary must independently evaluate and affirmatively approve the advice TCW renders, consistent with the fiduciary obligations imposed under Title I of ERISA. DOL has taken the position that the recipient of investment advice (e.g., the participants) cannot be independent of the person who gives the advice.
• Second, ERISA §408(a) requires, among other things, that DOL determines that before granting a prohibited transaction exemption that the transaction must be protective and in the interest of participants. The administrative record of PTE 77-4 demonstrates that no relief for the provision of investment advice was contemplated. Moreover, relief for the provision of investment advice probably would not be possible in the TCW case, given Ex. 2 under the 408(b) regulations, as the protection supplied by the fourth requirement of PTE 77-4 (i.e., an independent second fiduciary evaluating the advice) is simply not present.
• Third, PTE 77-4 is applicable to mutual funds, but the Trusts are commingled, group trusts which invest in, but are not themselves, mutual funds.
• Fourth, the regulations under ERISA §404(c) provide that if the conditions of such regulation are satisfied, a plan participant is not a fiduciary with respect to his or her account. Since it is likely that most of the transactions under the Program will comply with ERISA §404(c), participants who direct such transactions will not be fiduciaries. Therefore, it is not certain that such participants could qualify as “second fiduciaries” for PTE 77-4 purposes, when they are not specifically defined as such under PTE 77-4.
• Hence, for the aforementioned reasons, it would have involved some risk to assert that PTE 77-4 would provide relief with respect to the transactions which are an integral part of the Program.
• Thus, TCW sought and received exemptive relief from the restrictions of ERISA §406(a) and §406(b) with respect to the rendering of investment advice to Benefit Plan participants. In support of its request, TCW noted that its proposed exemption is similar to FITE 93-59 1 (Prudential Mutual Fund Management, Inc.) in which DOL allowed a non-discretionary investment advisor affiliated with the applicant to evaluate and recommend a mutual fund investment mix comprising mutual funds which were advised by the applicant, and is also similar to PTE 92-77 (Shearson Lehman Bros., Inc.) [25] DOL granted such exemptions, as the Program provides the following protections from overreaching and self-dealing.

   

  Protections Established Under the Program

  Structure of TCW Portfolio Solutions Life Cycle Trusts

  1. The asset allocation of the Trusts will be constructed by the Financial Expert, a party independent from TCW, using generally accepted principles of modern portfolio theory. No more than five percent (5%) of the Financial Expert’s gross income in any one of his taxable years will be derived from TCW or its affiliates. The allocation models will be entirely developed, maintained and if necessary modified by the Financial Expert.
  2. Separate Trust(s) which a Benefit Plan Sponsor constructs based on different weightings of the Galileo Funds may be utilized if the Financial Expert approves of such modification as being appropriate for that type of Trust.
  3. Rebalancing of each Trust will occur on a basis determined by the Financial Expert. The rebalancing will be purely objective, automatic, and mechanical, with the exclusive goal of maintaining the asset allocation model.
  4. TCW will not receive any fees other than those charged by the Galileo Funds. [26]

  Benefit Plan Sponsors

  1. TCW will market this product to sophisticated Benefit Plans, i.e., those with a minimum of $5 million in plan assets.
  2. TCW will provide Benefit Plan sponsors with full disclosure concerning the composition of the Trusts. If requested, TCW will also provide the mathematical formulae by which the asset allocations for each Trust were derived. TCW will also provide full written disclosure regarding all fees charged at the Fund and the Trust levels; in this connection, TCW will provide a copy of the Funds’ prospectus.
  3. TCW will provide Benefit Plan sponsors with a quantitative annual report by which each Benefit Plan sponsor may determine if the Program has attained its objectives. This ensures accountability on TCW’s part and assists the Benefit Plan sponsor in complying with its fiduciary responsibilities in monitoring TCW.

  Plan Participants

  1. (1) Standardized, objective advice to plan participants will be based on a participant’s responses in the Worksheets; TCW has no discretion to vary the advice proffered. The advice will be based on two primary elements: the participant’s funding needs and psychological profile as it relates to risk tolerance. However, the participants will voluntarily elect whether to follow the advice rendered.
  2. TCW will hire a respected, independent third party to formulate a risk profile. This Behavioral Expert will develop standards which will result in the ultimate recommendation to the participant, by determining whether a participant is likely to be able to maintain the optimal position (Trust) if a loss, equaling the largest that would be anticipated to occur in the great majority of the likely scenarios, does occur. If the participant is not likely to maintain the optimal position in the face of such a loss, a more conservative Trust will be recommended.
  3. Participants will receive full disclosure concerning the composition of the Trusts, and a description of the underlying Galileo Funds before they make such an investment. Participants will also receive, on request, a copy of the Funds’ prospectus.
  4. Participants will receive: (a) a description of the annual operating expenses of each Trust, and the aggregate amount of such expenses expressed as a percentage of average net assets; (b) information concerning the value of units in each Trust; and (c) information concerning the past and current investment performance of each Trust.

  THE EDUCATION ISSUE

  As mentioned above, DOL issued an IB [27] which encourages and facilitates the provision of investment education for participants and beneficiaries. The IB accomplishes this by describing information which will not constitute investment advice.

  Plan sponsors often inquire whether their fiduciary exposure would be lessened if they merely hire an entity to “educate” employees. It is the author’s contention that the provision of investment advice under the Program will lessen the fiduciary exposure of the Plan sponsors for the following reasons.

  The Nature of Education

  The Plan sponsor is responsible, as a fiduciary, for the selection and oversight of the “educator,” [28] but would not have the protective conditions and government approval [29] supplied by a prohibited transaction exemption. Further, such educator may be subject to all applicable state law [30] and not ERISA. This may permit an “educator” with a financial interest in what fund a participant selects (such as a sponsor of a mutual fund family) to skew the “education” to lead to the selection of funds which result in higher fees and profits for the “educator” without liability for the educator under ERISA. However, such a scenario would enhance the possibility of liability under ERISA for the plan sponsor for either improper selection or inadequate monitoring of the educator. Monitoring would have to include a determination that the “education” does not slip over the line and become “investment advice.” If the “education” turns out to be “investment advice,” and the educator receives different fees depending on which investment alternative is selected by an employee, the sponsor may find itself having hired a fiduciary on behalf of the plan, rather than merely an educator. If this is the case, the fiduciary will probably have engaged in “self dealing” which is prohibited under ERISA, since the investment advice probably would not be the subject of any exemption.

  Finally, many of the different state laws to which an educator may be subject may well have different standards than ERISA. This is a potential source of tension between the interests of the plan sponsor, which is subject to ERISA, and the educator, which is subject to a different legal standard. If an educator is held liable under state law for a violation, the holding may be evidence in a federal court that a plan sponsor has not satisfied ERISA’s prudence requirement in selecting and monitoring the “educator.” On the other hand, if the “educator” is held not liable under state law (because of less restrictive standards) for something that would be a violation under ERISA, the plan sponsor may still be liable for the imprudent selection or monitoring of the “educator,” since the looser state laws may have deprived the plan of a cause of action against the “educator.”

  Practical Effect of an Individual Prohibited Transaction Exemption

  DOL must, in order to grant a prohibited transaction exemption, find that the transaction is in the interest of employees. A transaction that is not prudent would not be in the interest of employees. Therefore, DOL only grants exemptions that incorporate conditions and procedures which DOL believes will insure, to the greatest possible extent, that transactions which it exempts are prudent.[31]

  DOL must also find that the terms of a transaction are protective of the rights of employees.[32] Accordingly, unless DOL is comfortable that the terms of a transaction are favorable to plan participants, it will not issue an exemption. In this connection, it is not unusual for DOL to insist that the terms of a transaction be made more favorable to plan participants than the, requester had initially requested before it will propose to issue a prohibited transaction.[33]

  The caution of DOL has bad a predictable result. Exhaustive computer searches have failed to uncover any case in which a party complying with the conditions of an individual prohibited transaction exemption was held liable for a breach of its fiduciary responsibilities. Further, the author has been unable to locate a single reported case in which a fiduciary breach was even alleged against such a person.

  This is encouraging for both TCW and any plan sponsor that retains TCW to provide investment advice to its employees. If TCW fulfills it fiduciary responsibilities to a plan, and all the conditions of the exemption are complied with, then it would take a truly imaginative plaintiff to originate a theory under which the Benefit Plan sponsor could be held liable for damages [34] for hiring or continuing to retain TCW. [35]

  CONCLUSION

  The TCW Portfolio Solutions Program is truly innovative in many ways, primarily in that it aligns competing and sometimes contradictory interests so that a true win-win situation occurs:

  1. By allowing for variable fees, there is no subsidizing by those participants in more conservative investments of those in more aggressive investments;
  2. Participants receive the investment advice they desire and need;
  3. Plan participation and retention rates should increase;
  4. TCW cannot skew to its own advantage the investment advice rendered; and
  5. Fiduciary exposure of Benefit Plan sponsors is reduced.

  The TCW Portfolio Solutions Program should become a popular mechanism in the self-directed, defined contribution market. It will be interesting to observe how the mutual fund/investment advice industry develops, after it digests and fully grasps the standard PTE 97-60 has created.

  Footnotes

  1. For simplicity, all future references to sections of ERISA should be assumed to include corresponding sections of the Code, unless the contrary is indicated specifically or by the context of the reference.
  2. For these purposes, the term “participants” include participants, beneficiaries and alternate payees who have the power to direct the investments of their account balances.
  3. Each Trust is a group trust, satisfying all requirements contained in Revenue Ruling 81-100, 1981-1 C.B. 326, and, thus, qualifies for tax exemption under Section 501 (a) of the Code.
  4. The Guaranteed Investment Contract or Money Market Fund are provided so that the Program may comply with the requirements of Section 404(c) of ERISA and the regulations promulgated thereunder.
  5. Currently, there are thirteen such Funds, although more may be added in the future.
  6. If a large plan so requests, TCW could construct an individualized arrangement utilizing separate Trusts with the same safeguards herein discussed.
  7. 29 CFR Part 2509, 29586 F.R. Vol. 61 No. 113 (June 11, 1996).
  8. An “Independent Fiduciary” means a Benefit Plan fiduciary who has discretionary authority with regard to the Benefit Plan and who is not affiliated with TCW. Thus, the term could include Benefit Plan named fiduciaries such as the plan sponsor or plan administrator or any fiduciary responsible for selecting investment vehicles for the Benefit Plan.
  9. For example, by computer or electronically, which modes of communication are considered for this purpose as if in written form.
  10. Some participants may elect not to participate in the asset allocation program, in which case a person independent of TCW, who would generally be the participant himself, will elect in which Trust to invest a participant’s account.
  11. “Appropriate asset allocation” means an allocation of assets which would be similar to that which would be made by a prudent professional fiduciary.
  12. Initially, there will be four Trusts, but more may be added in the future.
  13. The Financial Expert shall be Jeffrey F. Jaffee, Ph.D., an Associate Professor of Finance at the Wharton School of Business and Finance; the identity of the Financial Expert may vary from time to time.
  14. The Financial Expert may construct an individualized trust for certain plan sponsors upon their request. The asset class composition in such trusts may vary from that of the Trusts regularly offered to Benefit Plans.
  15. Ordinary income tax principles will be used to determine the amount and timing of the Financial Expert’s income for purposes of this limitation.
  16. Thus, TCW may find itself in the position of recommending a more conservative Trust than would be the case if the Worksheets had only a mathematical basis with no behavioral or psychological component. Since the equity-based Galileo Funds provide TCW with higher fees (and generally higher profits) than the bond-based Galileo Funds, TCW generally receives higher net profits when a participant invests in the more aggressive Trusts. Thus, by incorporating the behavioral or psychological component in the Worksheets as fundamental in determining the appropriate Trust, TCW may not maximize its short-term return.
  17. Within the meaning of 29 C.F.R. Sections 2550.408b-2(d) and 2550.408c-2.
  18. Within the meaning of 29 C.F.R. Section 2550.408b-2(b).
  19. Within the meaning of 29 C.F.R. Section 2550.408b-2(d).
  20. Within the meaning of 29 C.F.R. Sections 2550.408b-2(d) and 2550.408c-2.
  21. If additional services are requested and provided which are not necessary for the operation of the Program (e.g. record keeping of amounts or units in the participants’ individual accounts maintained under the Benefit Plan), the amount of such an expense is not considered in determining whether the 1.0% limit is exceeded.
  22. TCW acknowledges that it intends to provide investment advice.
  23. The application of these rules is illustrated by examples (1) and (2) of 29 C.F.R. Section 2550.408b-2(f), which are discussed above.
  24. Prohibited Transaction Class Exemption 77-4, 42 FR 18732 (April 8, 1977), permits an investment advisor to invest the assets of a benefit plan it advises on a fully discretionary basis in the open-end mutual funds managed by it or an affiliate, provided certain requirements are met.
  25. The Program may be more advantageous to Benefit Plans than either the Prudential or Shearson programs in that its fee structure more closely aligns the interests of TCW with those of the Benefit Plans which invest therein, as plan participants pay only those expenses associated with the Trusts in which they invest. In other words, the TCW Program provides variable fees, whereas the Prudential and Shearson programs provide flat fees, with offsets that could result in subsidization of one category of Benefit Plan investors of another. Moreover, under an exemption which provides for flat fees there is an incentive to steer participants to the investment alternative with the lowest operating expenses and therefore the highest profits. Selecting and monitoring such a program places a greater burden on the Benefit Plan fiduciary than under the TCW program, where the advice is formulated by a third party.
  26. It may, however, receive reimbursement for only those “direct expenses” associated with operating the Program or other expenses which it pays to unrelated third parties.
  27. Interpretive Bulletin 96-1, 29 CFR Part 2509, 29586 F.R. Vol. 61 No. 113 (June 11, 1996).
  28. See 29 C.F.R. 2509.96-1(e). This Section also notes that hiring a person as an investment advisor may result in co-fiduciary liability under Section 405 of ERISA if the fiduciary which hires such an advisor fails to carry out such designation in a manner consistent with the general fiduciary responsibility provisions of ERISA. However, there is no practical difference which would enhance a plan sponsor’s responsibility to select and monitor TCW when it serves as a fiduciary, as compared with an “educator”, where TCW’s conduct is circumscribed by an exemption.
  29. The Department must find, on the record, that an individual exemption is in the interests of employees before it grants such an exemption.
  30. See Coyne v. Selman, 98 F.3d 1457 (4th Cir. 1996), Curtis v. Nevada Bonding 53 F.3d 1023, 1027 (9th Cir. 1995) and Dukes v. U.S. Healthcare, Inc., 57 F.3d 350,355 (3rd Cir. 1995), cert. denied 116 S.Ct. 564 (U.S. 1995). In contrast, most state laws would not be applicable to TCW if it acts as a fiduciary. In this regard, Section 514 of ERISA generally preempts all state laws, except for those which relate to banking, insurance, securities, and generally applicable criminal law.
  31. While it is typical for the Department to disclaim any implication as to the prudence of the transaction, the legal standard of Section 408(a) of ERISA, which it must meet in order to grant an exemption, virtually compels it to review transactions and determine whether they are prudent.
  32. See Section 408(a)(3) of ERISA.
  33. In order to grant a prohibited transaction exemption, the Department must provide interested persons an opportunity for comment, by publishing the exemption in proposed form in the Federal Register.
  34. A fiduciary which hires a person which performs well could still be subject to equitable relief, such as removal, for not following proper procedures in hiring such person. See Brock v. Robbins, 830 F.2d 640, 648 (7th Cir. 1987). However, here the exemption itself supplies procedures, such as information which TCW must famish to plan sponsors, which are intended to insure that proper procedures will be used to select TCW.
  35. A Benefit Plan sponsor would have to make an initial determination that the investment advice furnished by TCW would be likely to be helpful to its employees.